Key Trends in the World Economy

China and developing economies will determine the chances for world growth in 2012

China’s economic growth has become a key factor not only for itself but for world markets. As the scale of China's impact is still too frequently underestimated it should be noted that, measured in current dollars and at market exchange rates, i.e. in terms of actual effective demand, in the three years following the start of the international financial crisis China contributed 33.4 per cent of global market growth – more than four times as much as the US 8.1 per cent (Table 1). While final data for 2011 is not yet available, it is already clear from the first three quarters figures that China’s market last year expanded by over $1 trillion – approximately twice as much in dollars as the US, despite US growth having resumed. Table 1 makes clear no other economy has approached China in terms of market/global aggregate demand expansion.

It is therefore a key question whether China will continue essentially the same scale of market growth in 2012. The answer is ‘yes’  - but because of the issue’s importance the reasons should be clearly outlined. Interlinked with this is the decisive role played by developing economies in recovery from the financial crisis – the interlinking being that China is by far the largest developing economy, while the developing economies have become China’s largest trade partners.

In the three years covering the period from the beginning of the international financial crisis to the latest available annual data, i.e. in 2007-2010, developing economies accounted for 78.6 per cent of world market growth and developed economies for only 21.4 per cent. Considered from another angle, simply taking different classifications, either the BRIC economies (Brazil, Russia, India and China), or China plus Latin America, contributed the majority of world market/effective demand expansion – either of these groupings accounting for more than twice as much market expansion as the developed economies.

Table 1

 

Turning to more detailed trends, the first feature determining China’s continued dominant position in world market expansion, one the consequences of which are insufficiently frequently noted, is that as China’s economy becomes larger a similar percentage yearly growth necessarily turns into an increasingly large annual absolute market increase - in inflation adjusted terms, China’s economy expanded by 2.3 trillion RMB in 2008, 2.4 trillion RMB in 2009, and 3.1 trillion RMB in 2010.

But even frequently cited constant price growth figures underestimate the expansion of China’s position in the world market. Actual sales, and therefore changes in aggregate demand, use real money which is affected by exchange rate shifts and inflation – further figures in this article are therefore at current market exchange rates and prices unless otherwise stated. In 2009, when China froze the RMB’s exchange rate due to the international financial crisis, China’s economy grew by $469 billion – compared to a US contraction of $353 billion. In 2010, when China allowed the RMB exchange rate to rise, its annual economic expansion rose to $935 billion and the figure will be over $1 trillion in 2011 – roughly twice US market expansion.

Table 1 also makes clear the second reason China’s market will continue  its expansion. World growth is now dominated by developing economies and China is their most rapidly expanding trading partner.

Considering trends among developing economies, China accounting for 33.4 per cent of global market expansion. Latin America was second – constituting 17.3 per cent of world growth, with Brazil accounting for 58 per cent of this. China and Latin America together accounted for 50.7 per cent of world market growth..

Among other developing economic regions, South Asia contributed 8.0 per cent to world market growth, with India accounting for 84 per cent of this. Developing East Asian economies, excluding China, accounted for 7.0 per cent of world growth – Indonesia constituting 54 per cent of this. The Middle East and North Africa accounted for 6.1 per cent of world growth with no single dominant regional economy – the largest contributor, Egypt, constituted only 19.9 per cent of the total. Developing countries in Europe and Central Asia accounted for 4.5 per cent of world growth – of which 55 per cent was Russia. Sub-Saharan Africa grew rapidly, but due to its low starting point only contributed 2.1 per cent of world growth.

Turning to developed economies, Japan illustrates the importance of currency movements for shifts in markets measured in dollar terms. Due to the yen’s sharp exchange rate rise, Japan contributed 14.9 per cent of the dollar expansion of the world market despite Japan’s economy contracting in inflation adjusted terms. The US contributed 8.2 per cent to world market growth, despite the US not having grown in constant price terms, due to the dollar rising against other currencies,

The ‘disaster area’ for world markets was the developed European economies with a decline of $668 billion - equivalent to subtracting 9.2 cent from world growth.

It is already clear 2012 will show no fundamental change in this pattern. Developed European economies will again be the worst performing region – suffering a recession possibly magnified by a low Euro exchange rate. The US should expand, but slowly compared to previous upswings in US business cycle. Therefore if the world economy is to grow this will again have to be primarily due to developing  economies.

Fortunately, the large developing economies are slowing but still growing substantially more rapidly than developed ones. China, the dominant factor in the equation, even on pessimistic estimates is likely to grow by at least 7-8 per cent in real terms this year which, after increases in the exchange rate of the RMB and inflation is take into account, means an expansion of its market of probably 12-15 per cent in dollar terms. Minimum real growth estimates for India are at least seven per cent.

It is also clear from the pattern in Table 1 why BRIC economies will again dominate world growth – in 2007-2010 they contributed 52.5 per cent of world market expansion. Not only are the BRICs individually the largest developing economies but each is the centre of a major regional economic area. While Brazil has slowed, Russia’s economy has been accelerating, and it is in any case China and India which are the dominant dynamic BRIC economies.

This overall situation clearly interrelates with China as it already carries out the majority of its trade with developing economies – 54 per cent of total trade, 49 per cent of exports and 60 per cent of imports.

The implications for China’s markets are clear. China has not only the world’s most rapidly expanding domestic market, and declining inflation gives it extra room for domestic economic loosening/stimulus in 2012, but its biggest trading partners are the most rapidly growing regions of the world economy. It is this combination of domestic and international factors which determines that  China will continue to remain the world’s most rapidly expanding market/supplier of increased aggregate demand in 2012. Given the negative prospects in Europe, and slow growth in the US, it will then be the situation in the developing economies, which is increasingly related to the situation in China, which will necessarily determine the overall prospects for world growth in 2012.

*   *   *

This is an expanded version of an article which originally appeared in Shanghai Daily.

The weakness in world trade - pre-crisis trade levels only regained in Asia and Latin America

Europe’s economy is probably entering a double-dip recession. The indications from world trade, as analysed previously, are so far that the world economy as a whole is facing slowdown but not renewed recession. However a detailed breakdown shows extreme unevenness in the trade recovery - with only Asia and Latin America surpassing pre-financial crisis levels. Regional trends for imports and exports, using a three month moving average to smooth short term fluctuations, are shown in Figures 1 and 2.

Considering trends in detail, pre-crisis world trade peaked in April 2008. In the latest month for which data is available, September 2011, world trade was 2.3 per cent above its pre-crisis maximum on individual month comparisons and 3.6 per cent above on a three monthly moving average.

Table 1 shows a detailed breakdown of trade since the financial crisis by region. This data shows that only in developing Asia and Latin America are both exports and imports clearly above pre-financial crisis levels. Taking three monthly moving averages, imports are up from pre-crisis levels by 16.7 per cent in developing Asia and 9.4 per cent in Latin America, with exports up 17.0 per cent in developing Asia and 6.9 per cent in Latin America. In the US exports are slightly above pre-crisis levels but imports are significantly below. In all other regions – the Euro area, Africa and the Middle East, Central and Eastern Europe, and Japan – both exports and imports remain below pre-crisis levels.

The recovery of world trade to above pre-crisis levels is therefore due to the situation in two developing regions. The weakness of trade in the Euro area is worse than most regions, particularly in terms of imports, but not really exceptional. Trade in most areas of the world economy remains significantly below pre-crisis levels.

Table 1

 

Trade with China

Among the largest economies the chief beneficiary of this pattern of world trade is China - although it is likely the pattern itself is in significant part a result of the dynamics of China's trade.

In the period between China's peak pre-crisis level of exports and imports, in July 2008, and September 2011 China's exports to Asian developing economies rose by 22.9 per cent and its imports from these economies rose 31.4 per cent. China's exports to Latin America rose by 53.0 per cent and its imports by 59.9 per cent. These are clearly exceptional growth rates. China is the main trade partner for most developing Asian economies as well as for a significant number of Latin American economies including Brazil.

The patterns of world trade since the financial crisis therefore indicate the consolidation of a dynamic trading interaction between China, developing Asia and Latin America. China's economy and trade is not yet sufficiently large to offset a global scale recession in the EU and/or US, but there is clear evidence that China's economy is sufficient to produce the most dynamic of post-crisis world trade interactions centred on Asia and Latin America.

Figure 1

Figure 2

During the last four years the EU's economy has grown by -0.3%, the US by 0.6%, and China by 42.2%

The full scale of the difference in economic performance of China compared to the US, Europe and Japan during the international financial crisis is shown in Figure 1. It is summarised in the following figures:

• In the four years to the latest available data, for the 3rd quarter of 2011, China’s GDP expanded by 42.2%
• In the four years to the latest available data, also for the 3rd quarter of 2011, US GDP increased by 0.6%.
• In the four years to the latest available data, for the 2nd quarter of 2011, European Union (EU) GDP shrank by 0.3%.
• In the four years to the latest available data, for the 2nd quarter of 2011, Japan’s GDP contracted by 5.2%.

Figure 1

 

 

These are evidently extraordinary statistics. During this four year period China’s economy expanded 70 times as fast as the US.

Such data also clearly refutes the current attempt to claim that in China there is an economic ‘crisis’ in some sense equivalent to that in the US or Europe. Such arguments are intellectually sloppy (at best) attempts to undermine rational thought by destroying any serious quantitative comparisons.  

To give examples of such claims, a recent article by Nouriel Roubini and Ian Bremmer in the Wall Street Journal is introduced: ‘With Europe, China and the U.S. in crisis, the real question is which of them will stumble first.’ Similarly Will Hutton in the UK’s Observer claims: ‘Nobody would start from here – an ill-designed single currency interacting with an insupportable burden of private debt created by oversized, undercapitalised banks. And it's as much a problem in the US and China as in Europe.’

The data given above shows such claims are false. GDP growth of 42.2% in China, an annualised 9.8%, is not remotely comparable to the US’s annualised 0.2%, or the EU’s annualised minus 0.1%.

Naturally it is impossible to have an annual 9.8% growth rate for almost four years and have no problems at all – in fact no economy ever has no problems! China has had consumer price inflation, primarily due to international commodity price increases, which reached 6.5% before falling and it has had excessively high house price increases – which are also now falling. But none of this constitutes a ‘crisis’ on anything quantitative scale remotely approaching that of the US and Europe.

Nor, to take Hutton’s point, does the EU financial crisis have anything like the same impact in China, or even the US, as in the EU. The effect of the decline in imports from the EU on China’s exports is noticeable but only in the sense that it reduces China’s overall export growth from a very high to a high rate of growth – 15.8% last month, in a factual situation in which none which China’s GDP growth in the last four years has come from net trade. Indeed reduction of China’s trade surplus means that net trade has been a subtraction from China’s GDP growth during that period. The exposure of China’s banks to Europe’s debt crisis is also minimal. While the financial exposure of the US to the Eurozone is certainly higher than China’s there is also no indication that the actual scale of crisis or defaults in Europe is pushing the US into recession – whereas a double dip recession in Europe itself is extremely possible.

Hutton, in short, is engaging in inflated rhetoric to attempt to create a relative equals sign between the situation in China (and the US) and that in Europe when none exists. Inflated rhetoric is merely a form of destroying the quantitative scale of comparison which is a precondition for rational thought.

The GDP data for China, US and Europe GDP data should also end attempts by Kate Mackenzie the Financial Times and Nouriel Roubini to present the US’s Michael Pettis, and similar analysts, as having had a correct analysis of China. Michael Pettis runs an objectively moderated blog on China but his analysis of China has been factually shown to be quite erroneous – claiming that: 'the US would be the first major economy out of the crisis and China one of the last.’ Evidently a situation where China has grown by 42.2% and the US has grown by 0.6% shows the reverse has been the case. Claims that it is too early to judge whether China or the US has been more successful in coming through the financial crisis are just attempts to avoid the test of facts that has taken place. Even if, against the evidence, China’s economy were now to slow significantly the scale of growth it has already achieved demonstrates that has come through the financial crisis far more successfully than the US or Europe.

The basis of any serious analysis or theory is facts. Those who refuse to refer to the data of the relative performance of China, the US or Europe during the last four years do so only because their analyses will not stand the test of examination by these facts.

China in face of the West's 'Great Stagnation'

I have a new article at China.org.cn which analyses the impact of the present 'Great Stagnation' in the developed economies on the prospects for China's economy.

It concludes:'Given extremely slow growth in the developed economies, and that examination of underlying macro-economic factors such as savings and investment indicates no reason to expect a substantial growth acceleration, this places China in a new international economic situation. For almost the entire period since China launched its economic reforms in 1978, it has been growing more rapidly than other economies but in an international context where the developed economies were growing significantly. The only serious previous recession in the advanced economies during China's reform period was right at its beginning, in 1980-81, when China was scarcely integrated in the international economy. The international slowdowns in 1990 and 2000 were brief and mild and while the 1998 South East Asian financial crisis impacted China significantly, it did not originate in the developed economies...

'In economics and business there is no virtue in either optimism or pessimism, there is only a virtue in realism. Given current trends, China has to base itself on a perspective that for several years there will be slow growth of the developed economies and therefore slow growth of their imports. Developing economies, while growing more rapidly than developed ones, will not in the very short term be able to fully compensate China's exports for stagnation in developed economies.

'The international framework for China's economy is therefore clear. It is important to understand that what is faced is a 'Great Stagnation' not a new 'Great Recession' - that is there is no reason to anticipate major international economic downturn of the 2008 type. China therefore does not need a new huge stimulus program of the type it launched in 2008 - which would lead to severe economic overheating. But the international economic situation requires adjustments in emphasis.

'First, even more than previously, China has to rely on developing domestic demand. Greater analytical clarity on this is important as at present domestic demand is frequently confused with domestic consumption - the two are not the same.

'Second, while developing economies will not immediately be able to fully make up for the negative pressure on China's exports from the 'Great Stagnation', they provide an important addition to China's domestic demand - in the last fifteen years the percentage of China's exports going to developing economies have risen from 35 percent to 50 percent. All developing economies face the Great Stagnation, therefore all face constriction on exports to developed countries, while China's imports are continuing to expand. This will produce greater integration of developing economies with China in both exports and imports.

'Within developing economies many of China's top companies, such as Huawei, Haier, and Lenovo already have high brand values and the present situation therefore creates opportunities to further enhance the positions of China's international brands.'

The full article, including a brief comparative analysis of the 3rd quarter US GDP figures with previous US post-war business cycles, may be found here.

Negative trends in world trade - further confirmation of economic slowdown

Attempts to assess current prospects for the world economy have primarily focused on deceleration  in US and European GDP growth. But world trade is clearly also indicating negative trends.

Trade is a particularly sensitive indicator as its fluctuations have had a greater magnitude than those for GDP but have moved in the same direction. Trade data is also useful in indicating current economic trends as it is available for recent periods for developing countries many of which do not publish quarterly, and therefore up to date, GDP data.

It is significant for indicating the state of the world economy that the overall volume of world trade is currently at best entirely static and may have turned down. It is important this is affecting both developed and developing economies.

World trade

Analysing first the overall trend in world trade, this is shown in Figure 1 - which charts percentage volume changes in world trade compared to the pre-financial crisis peak in April 2008. The numbers on the horizontal axis indicate the number of months since the peak. A three month moving average is used to remove the effect of purely monthly fluctuations.

World trade reached its post-crisis trough in May 2009 at 20.1 per cent below the previous peak. By March 2011 world trade had recovered to 3.5 per cent above the pre-crisis peak. World trade maintained that level in May 2011 and fell to 1.2 per cent above the pre-crisis peak in June – the latest available data. The June dip is only one month, and it is therefore too early to say a decline is taking place, but world trade growth has clearly stalled since March - i.e. since the end of the 1st quarter of 2011.

Theoretically, world exports and imports should naturally be identical, but due to problems in recording and calculation, there is always some disparity in the data. To avoid the possibility of statistical distortions Figure 2 therefore confirms that the same trend appears whether measures of exports or imports are taken.

Figure 1

Figure 2

 

Developed economy trade

It is significant that the downturn in trade has affected both developed and developing economies - Figure 3 shows the data for developed economies and Figure 4 that for developing ones.

Considering first trade of developed economies, it may be seen from Figure 3 that this has not yet recovered to pre-crisis levels either in exports or imports. Again using a three monthly moving average,  developed economy imports peaked in May at 4.6 per cent below their pre-crisis highest level and exports peaked in the same month at 6.5 per cent below their pre-crisis highest level.

Figure 3 shows that there is now no substantial increase in developed economies exports or imports.

Figure 3

 

Developing economies trade

Figure 4 shows the data for exports and imports for developing economies. Unlike developed economies, both exports and imports of developing economies rose to exceed pre-crisis peaks. Growth momentum in trade was continued for a slightly longer period in developing than in developed economies but has also recently stalled.

Taking a three month moving average, developing economy imports peaked at 11.2 per cent above their pre-crisis highest level in May 2011 before falling back to 8.4 per cent in June. Perhaps more significantly developing economies exports rose to 16.6 per cent above their highest pre-crisis levels in March and by June had slipped to 13.1 per cent above.

It would not be correct to project that trade of developing economies is falling, data over a longer period would be required to establish this, but it is clear that the upward momentum has ended.

Figure 4

 

This trend for developing economies is significant as recovery in their exports and imports was much more rapid and stronger than in developed economies.

China

Not all economies are witnessing trade stagnation. China's latest available data, for July, shows exports at an all time peak of $175 billion, up 20 per cent year on year, while China's imports were also up 23 per cent over the same period. China, however, clearly does not represent the overall trend in developing economies.

As the biggest factor in China's growth is now expansion of domestic demand, followed by exports to developing countries, and then exports to developed economies, there is no reason to revise the analysis made previously that the current world economic slowdown will not lead to substantial deceleration of China's GDP growth. However clearly trends in other developing, as well as developed, economies must be watched carefully for indications of how much they are able to deal with decelerations in export demand.

Conclusion

Overall the trends in world trade strongly confirm a picture of economic slowdown - and the wide spread of this phenomenon. China continues to stand out as the largest exception to the trend - the situation of other developing economies requires more detailed analysis. The present stagnation, at best, of trade in developed economies is evident.

 

More than three years without full economic recovery in the developed economies – the latest GDP figures in context

The publication of the European Union (EU) and German 2nd quarter GDP figures, following those for the US and Japan, completes the data regarding the state of the business recovery in the main developed economies. The picture is completely clear – Figure 1:

• By the 2nd quarter of 2011 none of the major regions among the developed economies has recovered their peak level of GDP more than three years after the high point of the previous business cycle.
• US GDP is 0.4% below its peak level in the 4th quarter of 2007.
• EU GDP is 1.8% below its peak level in the 1st quarter of 2008.
• Japan’s GDP is 6.0% below its peak level in the 1st quarter of 2008 – Japan’s data is of course affected by the earthquake and tsunami.

Overall, taking the period as a whole, this represents over three years of net negative growth in the developed economies. The key economic issue is not the possibility of a double dip recession, which the media is speculating on, but this extremely low growth rate even without one.

For comparison it may be noted that China’s economy has grown by over 30% in this same three year period.

Figure 1

What is China's present stage of economic development?

I have a new article at China.org.cn compariing China's present stage of economic development to the historical growth of Japan and South Korea. Its conclusion is:

'Today, China's Haier is the world's largest domestic appliance manufacturer, Huawei is likely to overtake Ericson as the world's largest telecoms equipment producer in the next two years, and China is already the world's largest manufacturer of high speed trains.In short, China's development today is entirely equivalent to Japan or South Korea at a similar stage of their economic growth.'

This provides the basis during the next years for international extension of China's leading brands - as occurred with Japan and South Korea..

Europe's 'stagnant middle' will determine EU's economic trajectory

Summary

Media attention regarding Europe's economy has largely focussed on the debt crisis in Greece, Ireland and Portugal, together with some discussion of whether the radical cuts in public spending in the UK will undermine its economic recovery. Both are important topics. However they are insufficient to answer a more general question – how well is the European Union (EU) recovering from the Great Recession?

This relates to another misunderstanding of the trend in Europe's economies - a tendency to present the situation as a 'two track Europe'. In this conception, there is primarily a division between ‘northern' and 'southern’ Europe – with the former recovering and the latter not (in this perspective Ireland is an honorary member of southern Europe).

Examination of factual trends, however, shows a different situation. There are three groups, not two, within the EU's economy:

• Significantly recovering economies - centred on Germany and France.
• Small economies which have undergone serious economic decline, of which the most well known cases are Greece and Ireland - but even taken as a group these are too small to determine the course of Europe's economy.
• A group centred on what may be termed the ‘large relatively stagnant economies’ - the UK, Italy and Spain, which underwent substantial economic decline and in which recovery is currently slow.

Due to their size it is likely to be this third group that determines the dynamic of the EUs economy in the coming period.

This article analyses these trends

The overall situation in the EU economy

To give a context for the the EU's economic performance, the overall trends in GDP in the three major centres of developed economies – the US, the EU, and Japan – are shown in Figure 1. This shows GDP since the peak of the previous business cycle.

Regarding the EU, its GDP in the last quarter of 2010 remained 2.8% below in its peak – the latter occurring in the 1st quarter of 2008. It is highly improbable that growth in the 1st quarter of 2011 will be sufficient to take EU GDP back to its previous peak level. Therefore, over a three year period, the EU will have experienced net negative growth.

To take a comparison, three years after the beginning of recession, US GDP just regained its previous peak level in the last quarter of 2010 - technically on OECD data it was 0.1% above it. Japan’s GDP remained 4.2% below its previous peak.

Figure 2 shows that there is no essential difference between the performance of the EU as a whole and that of the Eurozone. Therefore in this article concentration will be on the Eurozone plus the one large European economy outside it – the UK. Together these determine the European economic situation.

Figure 1

 

Figure 2

 

Three groups in the EU

Considering trends within the EU in more detail, three distinct groups in terms of economic recovery can be identified.

• The first group, centred on Germany and France, is enjoying relatively synchronised and significant recovery.
• A second group, consisting of Greece, Ireland, Estonia, and Slovenia has undergone severe economic contraction and recovery in these states is either limited or so far has not occurred. The combined GDP of these countries is, however, too small to determine the overall economic situation in the EU.
• A third group includes three major European economies – the UK, Italy and Spain. These underwent more substantial economic decline than the grouping centred on Germany and France. Recovery in this third group of economies substantially slowed during 2010. Given that these economies have significant economic weight, equal to approximately three quarters of the GDP of the states centred on Germany and France, it is the performance of what may be termed ‘large relatively stagnant economies’ that is likely to determine the course of the EU’s recovery as a whole. These might be termed so far 'Europe's stagnant middle'.

The three groups will be considered in turn.

German/French group of recovering economies

The first group of EU economies centres on Germany and France. Their situation is shown in Figure 3. All have recovered significantly from recession.

Both Germany and France are specified in this group as, contrary to some media impressions, Germany's overall economic performance during the ‘Great Recession’ has not, so far, been notably superior to France’s. While in the most recent quarters German economic growth has been more rapid than French, German economic decline at the beginning of the downturn was significantly greater than in France. Overall, by the 4th quarter of 2010, Germany and France’s economic recovery differed only marginally – Germany’s GDP being 1.4% below its previous peak and GDP in France being 1.6% below its peak.

Continuation of more rapid German economic growth in 2011 would, of course, alter this picture and create a situation of significantly superior German recovery. This trend must therefore be watched. However to date France’s economy has also recovered significantly.

The smaller states in this group of substantially recovering economies are the Netherlands, Belgium, Austria, Portugal, the Slovak Republic, and Luxembourg. The GDP of none, in the 4th quarter of 2010, was more than 2.1% below its previous peak level.

As analysed elsewhere, it remains to be seen if Portugal’s agreement of an austerity package with the EU will lead to it dropping out of this category.

The combined GDP of this group of economies, measured on an annualised basis in the 4th quarter of 2010, was $8.2 trillion, or 55% of the GDP of the combined Eurozone plus UK – Table 1.

The size of this group of economies is therefore substantial, but as it represents only slightly over half the GDP of the Eurozone economies plus the UK it is not sufficient in itself to determine the course of the EU’s economy. Only if these economies can act, together with other factors, as a locomotive for a wider range of states can Europe's broader economy undergo substantial or accelerated recovery.

Figure 3

Table 1

EU economies suffering sharp economic decline

The second economic group, which has received much attention due to the European debt crisis, includes the two economies which have agreed emergency debt packages with the EU – Greece and Ireland. Two other Eurozone economies, Estonia and Slovenia, have also suffered severe economic declines without having to reach debt agreements with the EU. In the case of all these economies, current GDP is at least 6% below the peak of the previous business cycle – Figure 4.

Slovenia and Estonia are undergoing some recovery. Greece and Ireland, in the 4th quarter of 2010 were still undergoing economic decline.

The financial impact of the crises in Greece and Ireland was, of course, considerable. The economic impact of their recessions on the population of these countries is severe. But this entire group of economies is too small to determine the economic course of the EU or Eurozone. Their collective GDP, $0.5 trillion, is significantly smaller than that of the Netherlands alone, and less than 4% of the total GDP of the Eurozone plus the UK. It is only 7% of the size of the recovering economy group centred on Germany and France – Table 2.

While this group of economies has received great publicity due to the impact of the debt crisis, it is therefore too small to directly inflect the course of EU GDP.

Figure 4

Table 2

Large and relatively stagnant EU economies

The third group, which may be charcterised as ‘large and relatively stagnant economies’ –  is constituted by the UK, Italy and Spain. These underwent both more substantial recession than the group centred on Germany and France and their recovery is much weaker. In each case their GDP’s remain 4-6% below previous peak levels – Figure 5. In the 4th quarter of 2010 Spain's GDP was 4.3% below its peak, the UK's 4.6% below, and Italy's 5.2% below. In Italy and Spain, after the decline during the recession, recovery has been extremely weak, while in the UK there was significant recovery during 2009 which then stalled in the the last quarter of 2010.

Finland's much smaller economy falls in the same range of percentage decline but its recent grown has been more dynamic.

These economies are substantial, accounting for 42% of the GDP of the Eurozone plus the UK.

It is clear that without serious recovery in the three large economies in this group, France and Germany by themselves are not large enough to lead to rapid economic recovery in the EU as a whole. It is therefore in these economies constituting 'the stagnant middle' that the trajectory of Europe's economy will be decided.

Figure 5

Table 3

Conclusion

The analysis of Europe's economy as being essentially divided into a 'recovering north' and a 'crisis ridden south' is not accurate. A bloc of countries centring on Germany and France is clearly recovering. A number of states, most spectacularly Greece and Ireland, remain in deep crisis but are too small to determine the overall economic trajectory in Europe. It is therefore likely to be the so far 'stagnant middle' - the UK, Spain and Italy - which detemines whether relatively rapid recovery remains confined to economies centred on Germany and France or spreads to Europe as a whole.

Regarding this group of economies, the evident key factors will be the unwinding of the property bubble in Spain, the impact of the deep cuts in public spending in the UK, and whether Italy can break out of what is now a prolonged economic stagnation - Italy's average annual growth rate over the last 20 years is 0.9%, a performance as bad as Japan's.

The UK, Italian and Spanish cases should therefore be analysed not only individually but in terms of their impact on the trajectory of Europe's economy as a whole.

Labour inputs in stages of economic development – trends revealed in the data of Jorgenson and Vu

Summary

An earlier article (Ross, 2010 August) analysed trends in the contribution of capital investment to GDP growth in the database published by Jorgenson and Vu of growth accounting data for economies compromising more than 95% of world GDP. (Jorgenson & Vu, 2007b) Jorgenson and Vu themselves drew attention to two trends:

• Factor inputs of capital and labour greatly predominate over total factor productivity [TFP] in percentage contribution to international GDP growth.
• The increasing role played by capital investment in information technology (IT).

Analysis of this database by the present author showed another trend. (Ross, 2010 August)

• Developed economies have a capital-intensive path of growth compared to developing economies – i.e. the percentage contribution of capital investment to GDP growth is higher in developed than developing economies. The East Asian/Asian developing economies are an intermediate group - the percentage contribution to GDP growth of capital investment in these economies is greater than in the majority of developing economies but less than in developed economies.

This previous article looked only at investment in capital. It did not examine improvements in labour quality, which typically requires investment in human capital. This was because the percentage contribution to GDP growth of investment in physical capital in developed economies considerably exceeds that of improvements in labour quality and, for clarity, it was therefore helpful to concentrate on the primary trend.

It is, however, also revealing to analyse the combined contribution of physical capital and improvements in labour quality – in particular given this has direct practical implications. Investment in physical capital and improvements in labour quality require expenditure/investment – the latter in education, training etc. Taking capital investment and improvements in labour quality together, therefore, gives an indicator of the different patterns of such expenditure and investment in economies at different stages of development.

The present article therefore supplements the previous one by analysing the contribution of labour inputs in different economy groups.

It should be pointed out that while this paper utilises calculations based on data produced by Jorgenson and Vu they do not bear responsibility for conclusions drawn in the present article.

Capital-intensive and labour-intensive patterns of growth

The basic data for the present analysis is set out in Table 1 and Table 2. These show the percentage contribution to GDP growth of capital, labour and TFP, and of labour hours and labour quality, in economy groups for the periods 1995-2000, 1995-2000, and 2000-2006 as calculated from the data set out by Jorgenson and Vu (Jorgenson & Vu, 2007b). The pattern of the contribution of capital investment to GDP growth in the different economy groups was already analysed in the previous article and is therefore merely summarised here. (1) If the non-generally applicable case of East European economies, experiencing transition from Communism to capitalism, is left aside the patterns of growth of economies fall into two large groups according to their stage of economic development.

• The first are developed economies – the G7 and the 15 additional non-G7 developed economies. In the developed economies the percentage contribution to GDP growth of capital inputs exceeds the contribution of either labour or TFP in all periods – i.e. developed economies display capital-intensive growth.
• The second group are the majority of developing economies - in Sub-Saharan Africa, Latin America, the Middle East and North Africa. In these, with only one exception, Sub-Saharan Africa in 2000-2006, the percentage contribution of labour inputs exceeded the contribution of either capital or TFP in all periods – i.e. the majority of developing economies show labour-intensive growth. (2)

The Asian developing economies, in particular East Asian developing economies, are ‘intermediate’ between the developed and the majority of developing economies.

• In the Asian/East Asian economies the percentage contribution of capital inputs to GDP growth was larger than in the other developing economy groups in all periods. However in no period was the percentage contribution of capital inputs to GDP growth in the Asian/East Asian developing economies as high as in the G7. In two periods out of three the percentage contribution of capital inputs to GDP growth was lower in the Asian/East Asian developing economies than in the non-G7 developed economies.

It is notable that neither in the developed economies groups nor in the majority of developing economies was TFP growth the main percentage contributor to GDP growth. (3) This trend in developed and developing economies is of course in line with the overall conclusion of Jorgenson and Vu: ‘‘We allocate the growth of world output, as measured in the World Bank’s International Comparison Program, between input growth and productivity. We find… that input growth greatly predominates. ‘(Jorgenson & Vu, 2009)

Trends in labour inputs will be analysed in conjunction with this overall framework.

Trends in labour inputs

First labour inputs in the developed economies will be considered in Jorgenson and Vu's data and then those in differing groups of developing economies.

i. The Developed Economies

As already noted, both the G7 and the non-G7 groups of developed economies follow a pattern of capital-intensive growth – i.e. in all periods the contribution of capital inputs to GDP growth exceeds the contribution of either labour or TFP. However, G7 and non-G7 economies differ in the role played by different forms of labour inputs.

The contribution of increases in labour hours in all periods is smaller in the G7 than in the non-G7 economies.

In the G7 economies, in two periods out of three, the percentage contribution of labour quality to GDP growth exceeds that of increase in labour hours, whereas in two periods out of three in non-G7 developed economies the contribution of labour hours exceed the contribution of labour quality. That is, the bias in G7 economies within labour inputs is towards a higher percentage contribution of labour quality than labour hours, whereas in the non-G7 economies the bias is towards a higher contribution of labour hours than labour quality.

There is also a difference between forms of labour input and TFP growth in the G7 and non-G7 developed economies. In the G7 economies, in two out of three periods, the percentage contribution of TFP exceeds the total contribution of labour inputs, and in all periods the percentage contribution of TFP to GDP growth exceeds the contribution of either labour hours or labour quality considered individually. In contrast, in all periods, in the non-G7 developed economies the contribution of labour inputs exceeds the contribution of TFP growth.

In short, in both G7 and non-G7 developed economies the predominant contribution to GDP growth comes from capital inputs. But the pattern of growth in the G7 economies is predominantly based on ‘capital investment, plus increases in TFP and labour quality’, whereas in the non-G7 developed economies the pattern of growth is predominantly based on ‘capital investment, plus increases in labour inputs - in particular increases in labour hours’.

The dominance of capital inputs and labour quality in the G7 economies may be seen clearly in Table 1. The combination of capital inputs plus labour quality inputs plays an overwhelmingly dominant role in the contribution to GDP growth in the G7 economies – accounting in successive periods for 74.9%, 61.6% and 68.5% of GDP growth.

ii. Developing economies in Sub-Saharan Africa, Latin America, and the Middle East and North Africa

The dominant role played by labour inputs in GDP growth in the developing economies of Sub-Saharan Africa, Latin America, and the Middle East and North Africa is shown in that in all groups and periods except one, Sub-Saharan in 2000-2006, labour inputs exceeds either the input of capital or the input of TFP to GDP growth.

The contribution of labour inputs to GDP growth exceeds the contribution of TFP in all these economy groups in all periods .

Within this framework the dominance of increases in labour hours over increases in labour quality is clear. The percentage contribution of increases in labour hours exceeds the percentage contribution of increases in labour quality in all three economy groups in all three periods.

The pattern of growth of the majority of developing economies is therefore not only labour-intensive, but within that framework it is dominated by increases in labour hours rather than increases in labour quality.

iii. Developing Asian economies

In the developing Asian economies the percentage contribution of capital to GDP growth exceeds the contribution of labour in all periods. The percentage contribution of TFP also exceeds that of labour in all periods. In this overall pattern of higher inputs of capital and TFP than of labour inputs Asian developing economies are closest to the G7 group.

However, the pattern of labour inputs in the developing Asian economies differs markedly from the G7 economies. In all periods in the developing Asian economies, the percentage contribution of labour hours exceeds the percentage contribution of labour quality.

The pattern of growth of the Asian developing economies is therefore primarily based on inputs of capital, TFP and labour hours with a smaller percentage contribution from improvements in labour quality. If the developing Asian economies resemble the developed economies in the dominance of capital inputs over labour inputs, nevertheless within labour inputs the Asian economies resemble developing economies in that increases in labour hours predominate over increases in labour quality.

The Asian developing economies may therefore be taken as being ‘intermediate’ between the developing and developed economies in a dual sense.

• In terms of the contribution of capital inputs to GDP growth the Asian developing economies have clearly moved out of the ranks of developing economies closer to the capital-intensive pattern of growth in the developed economies - although the contribution of capital investment to growth in the developing Asian economies has still not yet reached the level of the developed economies.
• The developing Asian economies, unlike in particular the G7 economies, however continue to have a pattern of development similar to the majority of developing economies whereby inputs of labour hours are greater contribution to labour inputs than increases in labour quality.

Conclusion

These trends may now be summarised.

• The fundamental pattern of development whereby developed economies follow a pattern of capital-intensive growth and developing economies one of labour-intensive growth has already been noted. (Ross, 2010 August)
• Developing Asian/East Asian economies may be understood as occupying a position of transition from developing to developed status, with a capital-intensity of development that is higher than the other groups of developing economies but not as high as that of the developed economies.

In may, however, be seen from the present analysis that a second trend also occurs within labour inputs.

• The pattern of GDP growth of the developing economies is not only labour-intensive but, within that framework, is primarily dominated by increases in labour hours rather than by increases in labour quality.
• In the G7 group, in contrast, increases in labour inputs are somewhat more determined by increases in labour quality than by increases in labour hours.
• In the percentage contribution within labour inputs, the Asian/East Asian developing economies remain closer to developing economies than to the G7 in that the contribution of labour hours is greater than the contribution of labour quality.
• In terms of labour inputs, the Asian/East Asian developing economies are closer to the non-G7 developed economies than the G7, in that, unlike the G7, both groups tend to remain far more dependent on increases in labour hours than increases in labour quality for labour inputs.

There therefore appears to be a progressive development pattern, in terms of labour inputs, whereby most developing economies, including in this case Asia, have a larger contribution of labour hours than labour quality, the non-G7 developing economies retain this characteristic on a lesser scale, and the G7 economies have the greatest percentage contribution of increases in labour quality compared to increases in labour hours.

The pattern of economic development shown in the data of Jorgenson and Vu is therefore of an increase in the percentage contribution of capital to GDP growth compared to labour, and of an increase of improvements in labour quality compared to labour hours.

* * *

Since this analysis was carried out Jorgenson and Vu have extended their data to 2008. (Jorgenson & Vu, 2010) The new data does not alter the main trends analysed above. A detailed analysis from the angle of approach in this article will be published here.

Table 1

Table 2

 

Bibliography

The transition from labour-intensive to capital-intensive growth during economic development – trends revealed in the data of Jorgenson and Vu

Summary

One of the most important databases and analyses regarding the international economy released in the recent period is that calculated by Jorgenson and Vu to evaluate the relative contributions of capital, particularly information technology (IT), and labour inputs compared to that of total factor productivity (TFP) in GDP growth ((Jorgenson & Vu, 2007a), (Vu, 2007)) This has formed part of the World Bank’s International Comparison Programme (Jorgenson & Vu, 2009)). Because of the comprehensive nature of the published data trends can be identified in addition to those emphasised by Jorgenson and Vu themselves.

One of the most important of such trends is clear evidence that as economies become more developed the contribution of capital inputs to GDP growth increases relative to that of labour inputs, i.e. ‘capital-intensive’ growth replaces ‘labour-intensive’ growth. Such a pattern of transition from labour-intensive to capital-intensive growth with economic development would be important in itself and indicate a confirmation of analyses in classical economic theory.

The present article outlines these trends. It should be pointed out that while this paper utilises calculations based on data produced by Jorgenson and Vu they do not bear responsibility for conclusions drawn in the present article.

Source of economic growth in developed and developing economies

Table 1 sets out annual average GDP growth, together with the percentage contributions of capital, labour, and TFP, for 109 economies, 22 developed and 87 developing, for the ten year period 1995-2005. The calculations are from the data set out by Vu (Vu, 2007). Subgroups for developed and developing economies are shown. Table 2 sets out similar calculations from the data for periods defined by Jorgenson and Vu - 1989-1995, 1995-2000 and 2000-2005 (Jorgenson & Vu, 2007b).

In addition to periodisations, other differences between the two tables should be noted. Table 1 shows unweighted means and medians – i.e. the significance of each country is treated as equal, whereas the data of Jorgenson and Vu in Table 2 is weighted. In Table 1 improvements in labour quality are included in TFP, as in the data presented by Vu (Vu, 2007), whereas in Table 2 improvements in labour quality are included in labour inputs (Jorgenson & Vu, 2007b). There are 109 countries in Table 1 compared to 122 countries in Table 2. As will be seen, however, such differences do not alter the qualitative trends found.

The dominance of factor inputs in GDP growth

One of the fundamental findings of Jorgenson and Vu, shown in both Table 1 and Table 2, is the dominance of factor inputs of capital and labour compared to TFP in international economic growth. Taking all economies in Table 1, the mean percentage of growth accounted for by increases in inputs of capital and labour is 74.8% and the contribution of TFP growth is 25.1%. Taking the three periods defined by Jorgenson and Vu in Table 2, the contribution of factor inputs of capital and labour to GDP growth is 83.7%, 76.8% and 64.3%. From their data Jorgenson and Vu conclude: ‘We allocate the growth of world output, as measured in the World Bank’s International Comparison Program, between input growth and productivity. We find… that input growth greatly predominates. ‘(Jorgenson & Vu, 2009)

Role of capital inputs

Turning to a more detailed breakdown, the greatest contribution to GDP growth is from increase in capital inputs. Taking all economies in Table 1, the mean percentage contribution of increases in capital to GDP growth is 39.6% and the median contribution is 42.6% - which is above the mean of 35.2% and median of 35.1% for the contribution of increase in labour hours, which itself exceeds the mean contribution of TFP growth of 25.1% and median contribution of 25.1%.

Taking the periods defined by Jorgenson and Vu, the contribution of capital inputs to GDP growth is greater than either labour hours or TFP in all periods - at 54.1%, 46.4% and 40.7%. Jorgenson and Vu conclude: ‘About 40-45% of world growth can be attributed to the accumulation and deployment of capital and another 25-33% to the use of labour input… productivity accounted for only 20-35% of growth.’ (Jorgenson & Vu, 2009)

The different pattern of growth in developed and developing economies

Taking the data in Table 1, however, there is a clear contrast in the pattern of growth between developed and developing economies. The contribution of increases in capital inputs is significantly greater in the developed economies than in the developing ones – i.e. developed economies follow a ‘capital-intense’ path of development compared to developing economies. Considering all economies in Table 1, the mean contribution of capital inputs to GDP growth in developed economies is 52.9%, significantly above the 36.3% in developing economies. The median contribution of capital inputs to growth in developed economies is 50.6% compared to 39.3% in developing economies. 

Table 1

Table 2 

In contrast to developed economies ‘capital-intense’ path of growth, the contribution of labour inputs to GDP growth is significantly higher in developing economies than in developed ones – i.e. in contrast to developed economies, developing economies have a ‘labour intense’ path of growth. The mean contribution of inputs of labour hours to GDP growth is 38.3% in developing economies compared to only 23.1% for developed economies, while the median contribution of increase in labour hours to GDP growth is 40.6% in developing economies compared to 23.8% for developed economies.

Summary of trends

Consolidating the above data, capital inputs are the dominant contribution to GDP growth in developed economies whereas the role of labour hours exceeds capital inputs in developing economies even if improvements in labour quality are included in TFP. The mean contributions to GDP growth in developed economies are, in order of percentage contribution, capital 52.9%, TFP 24.0%, and labour hours 23.1%, compared to, in developing economies, 38.3% labour hours, 36.3% capital, and 25.4% TFP. The median contributions to GDP growth in developed economies are capital 50.6%, TFP 26.0%, and labour hours 23.8%, compared to 40.6% labour hours, 39.3% capital, and 25.0% TFP in developing economies.

To see these trends visually, the mean percentage contribution of capital, labour hours and TFP to GDP growth for developed and developing countries is shown in Figure 1 and the median contributions in Figure 2.

Figure 1

Figure 2

  
 

Periodisation of Jorgenson and Vu

Jorgenson and Vu in their papers do not present a consolidated figure for all developed and all developing economies but the same pattern as in Table 1 may be seen from the data in Table 2:(1)

• In Jorgenson and Vu’s data, the percentage contribution of capital inputs to GDP growth in the G7 economies is the highest for any group in all periods. In all three periods capital investment contributed more than 50% of GDP growth in G7 economies. The capital-intensive path of development of G7 economies is therefore evident.

• The contribution of capital to GDP growth for the non-G7 developed economies is lower than for the G7 in all periods, but it is also higher than in the non-Asian developing countries in all periods. The contribution of capital to GDP growth for the non-G7 developed economies is higher than in the developing Asian economies for two periods and lower in one. This overall pattern confirms that, after the G7, the group of economies most dependent on capital investment for GDP growth is the non-G7 developed economies - although the gap with the East Asian developing economies is not great.
• The contribution of capital to GDP growth in the developing Asian economies is higher than for all other groups of developing economies in all periods – i.e. among developing economies the Asian economies most resemble the developed economies in the high intensity of capital investment in GDP growth.

• For the Latin American, Sub-Saharan African, and North African and Middle Eastern developing country groups, with only one exception, Sub-Saharan Africa in 2000-2006, the contribution of labour inputs to GDP growth exceeds the contribution of capital inputs to GDP growth in all periods.

• Eastern Europe(2), undergoing transition from Communism to capitalism, differs sharply from all other groups in that growth has weak inputs of capital and labour and relies primarily relied on TFP increases.

Therefore, although Jorgenson and Vu do not present a consolidated figure for developed and developing countries, the more capital-intensive character of economic growth in the developed economies compared to most developing economies is clear in their periodisation. Developing Asian economies constitute an ‘intermediate’ group between the majority of developing economies and the developed economies. The percentage contribution of capital to GDP growth in the periods and for the country groups defined in Jorgenson and Vu is shown visually in Figure 3.

More detailed analysis by country group within the above overall trends will now be considered. 

Figure 3

The G7

The ‘capital-intensive’ pattern of development of the G7 economies is clear.(3) Taking the period 1995-2005 the G7 is the most capital-intensive in terms of its pattern of growth of any economy group. The mean contribution of capital inputs to GDP growth is 60.3% for the G7 compared to 39.6% for all economies, and the median contribution of capital inputs to GDP growth in the G7 is 50.9% compared to 42.6% for all economies - see Table 3.

Taking the periodisations of Jorgenson and Vu, shown in Table 2, the percentage contribution of capital inputs to GDP growth in the G7 is 60.0%, 53.4% and 56.3% - the highest of all groups for all periods.

The relative contribution of increases in labour hours to GDP growth in the G7 economies is low – a mean of 11.3% in the G7 economies compared to 35.2% in all economies and a median of 15.9% in the G7 economies compared to 35.1% for all economies. Taking the periodisation of Jorgenson and Vu the percentage contribution of labour inputs to GDP growth in the G7 is below the average for all economies in all periods.

The G7 economies therefore have a clear ‘capital intensive/low growth of labour inputs’ pattern of development.

Table 3

Non-G7 developed economies

The pattern of development of the non-G7 developed economies also shows a capital intensive path of development compared to developing economies.(4) Taking the period 1995-2005, the mean contribution of capital inputs to GDP growth is 49.5% for non-G7 developed economies compared to 36.3% for developing economies - the median contribution is 50.3% compared to 39.3% for developing economies. Compared to the G7, the contribution of capital inputs to GDP growth for non-G7 developed economies is either slightly lower or the same as for G7 economies – the mean for G7 economies being 60.3% and that for non-G7 developing economies being 49.5%. The median for the G7 economies is 50.9% and the median for non-G7 developed economies is 50.3%.

Taking the periodisation of Jorgenson and Vu, the non-G7 developed economies have a higher percentage contribution to GDP growth of capital inputs than all developing economy groups in all periods with the one exception of the East Asian developing economies in 2000-2005 – i.e. the more capital-intensive path of economic development in the non-G7 developed economies compared to developing economies is clear.

Given both G7 and the non-G7 developed economies have a more capital-intensive pattern of growth than developing economies, the more capital intensive growth of developed economies compared to developing economies is clear. 

Table 4

East Asian and Asian developing economies

Jorgenson and Vu analyse the developing Asian economies as a single group – see Table 2. It may be preferable to divide them into an East Asian and a South Asian group – although the distinction is not vital from the point of view of the trends considered in this article. First the East Asian group will be considered and then the developing Asian economies as a whole.

The pattern of growth of the East Asian developing economies in the period 1995-2005 is shown in Table 5.(5) The East Asian group of developing economies are slightly less capital intensive in their path of development than the G7 and non-G7 developed economies – although the difference is not great. The mean percentage contribution of capital to GDP growth is 60.3% in the G7, 49.5% in the non-G7 Developed Economies and 47.2% in the East Asian Developing Economies, while the median contribution is 50.9% in the G7, 50.3% in the non-G7 Developed Economies and 48.4% in the East Asian economies. Overall, however, the East Asian developing economies clearly show a relatively similar capital-intensive path of GDP growth as the developed economies.

Taking the periodisation of Jorgenson and Vu, as shown in Table 2, and considering the developing Asian economies as whole, then as already noted the developing Asian economies have a lower percentage contribution to GDP growth of capital inputs compared to the G7 for all periods and compared to the non-G7 developed economies for two out of three periods. However, the developing Asian economies have a higher percentage contribution of capital inputs to GDP growth than all other groups of developing economies for all periods. The intermediate situation of the Asian/East Asian developing economies, in terms of capital-intensity of growth, between the developed economies and the other developing economies is therefore clear.

The developing East Asian/developing Asian economies are, however, not equidistant between the developed and the developing economies in their pattern of growth. Their pattern of growth, while not as capital-intensive as the developed economies is nevertheless closer, in its capital-intensity, to the developed economies than to the majority of developing economies.

Table 5

Other developing economies

Turning to wider groups of developing economies, Table 6 shows the pattern of GDP growth for the period 1995-2005 for developing economies excluding East Asia, which have already been examined, and Eastern Europe – which is analysed below. This covers 63 developing economies in South Asia, (6) Latin America,(7) Sub-Saharan Africa(8) and the Middle East and North Africa(9). This constitutes the majority of developing economies. The pattern of growth of these developing economies, compared to the developed economies and the developing East Asian/developing Asian economies, is clear. Unlike the developed economies and East Asian developing economies, GDP growth in these other groups of developing economies is dominated by labour inputs.

Taking the period 1995-2005 the mean contribution of inputs of labour hours for the 63 developing economies is 50.1% - compared to 28.8% for the East Asian developing economies, 28.5% for the non-G7 developed economies, and 11.3% for the G7 economies. The median contribution of inputs of labour hours is 44.2% compared to 26.9% for the East Asian developing economies, 24.5% for the non-G7 developing economies and 15.9% for the G7 economies.

Taking the periodisation of Jorgenson and Vu, as set out in Table 2, and taking their groupings of Sub-Saharan African, Latin American, and North African and Middle Eastern developing economies, the percentage contribution of inputs of labour is the highest input to GDP growth in all groups in all the periods up to 2006 except for Sub-Saharan Africa in 2000-2006.

The more labour-intensive path of growth of the majority of developing countries is clear.

Table 6

Eastern Europe and the former USSR

It may be seen from Table 2 that the pattern of economic changes in Eastern Europe in the period studied differed fundamentally from the rest of the world economy.(10)
The East European economies suffered severe falls in production in the early 1990s – this lasting until 1998 in the case of the former USSR.(11) The percentage contribution to GDP growth of input of labour hours in Eastern Europe and the former USSR was negative. The contribution of increase in capital inputs to GDP growth was very weak by comparison to the rest of the world economy. Taking the periodisation of Jorgenson and Vu, as shown in Table 2, after being negative in 1989-95, TFP accounted for 136.1% of GDP growth in Eastern Europe in the period 1995-2000, and for 88.9% in the period 2000-2005 – i.e unlike the rest of the world economy growth in Eastern Europe was overwhelmingly due to TFP increases.

This unique situation in the East European economies statistically raises the percentage contribution of TFP to GDP growth for the total economies in Table 1 and Table 2. However as Eastern Europe accounted for only 6.6% of the GDP of all countries analysed in 1989-1995, and only 5.5% in 1995-2000 and 2000-2005, the combined size of these economies is too small to alter substantively either the overall balance between inputs of capital and labour and TFP, or the capital intensive pattern of GDP growth of the developed economies.

The dependence of economic development on TFP growth in Eastern Europe may be regarded as either a unique one off event, due to the collapse of the former economic system in Eastern Europe and the former USSR, therefore not giving general lessons for economic growth, or treated as that in any period there will be statistical outliers. A case can therefore be made for excluding Eastern Europe and the former USSR from comparisons, on the grounds of their undergoing a unique experience, which would lower the average international contribution of TFP to GDP growth. However, in order to avoid the suggestion of selective inclusion of data, the case considered here is that of all economies including Eastern Europe.

Relevance to the path of development in classical economic theory

The finding that developed economies follow a capital-intensive path of growth compared to most developing economies, with the East Asian/Asian developing economies forming an intermediate group between the developed economies and other developing economies would be, of course, important in itself. It however would also cast light on an important issue in economic theory.

In the classic founding work of modern economics, The Wealth of Nations, Adam Smith analysed that the role of capital and intermediate inputs, which he jointly termed ‘stock’, would increase as an economy developed. Smith noted: ‘As the accumulation of stock must, in the nature of things, be previous to the division of labour, so labour can be more and more subdivided in proportion only as stock is previously more and more accumulated… As the division of labour advances, therefore, in order to give constant employment to an equal number of workmen, an equal stock of provisions, and a greater stock of materials and tools than what would have been necessary in a ruder state of things must be accumulated beforehand.’(Smith, 1999, p. 372) Other economists, including Keynes, arrived at the same conclusion of an increasing role of capital investment in economic development via a somewhat different chain of reasoning.(12) (For a wider discussion see Ross, 2009).

Smith, of course, had no systematic econometric data of the modern type with which to verify his findings – his conclusion was based on theoretical reasoning drawn from particular observations. Jorgenson and his collaborators have, however, already found that intermediate inputs, one element of Smith’s category of ‘stock’, grow more rapidly than capital, labour or TFP.(13) The finding in the data of Jorgenson and Vu that the percentage contribution of capital inputs to GDP growth is higher in developed than in developing economies is therefore also in line with, and casts important light on, Smith’s analysis and that of his successors.

Contrast of classical economic formulations with others

The pattern in the data calculated by Jorgenson and Vu is in line with classical economics. It however does not support other more recent theories regarding economic development. These contrasting views of the pattern of economic development are:

• Classical economic theory, as originally formulated by Adam Smith, foresaw a dynamic of transition from labour-intensive growth to more capital-intensive growth during economic development.

• Alternative theories, for example popularised by Krugman in regard to the East Asian economies (Krugman, 1994), instead suggested that the dynamic in economic development is one from growth dominated by factor inputs of capital and labour to one dominated by TFP growth in the most developed economies. (14)

The data presented by Jorgenson and Vu provides substantial evidence for the analysis of classical economics that economic development is accompanied by a transition from labour intensive to capital intensive growth. It however provides no evidence for the view that economic development leads to a greater role being played by TFP rather than factor inputs. Taking the six comparisons in the periodisation of Jorgenson and Vu (the two sets of developed economies, the G7 and the non-G7, times the three periods 1989-1995, 1995-2000, 2000-2005) TFP growth makes a lower percentage contribution to GDP growth in the developed economies than the average for all economies in four periods and a higher contribution in only two.

Conclusion

Jorgenson and Vu, in analysing their data, have emphasised:

• that capital and labour inputs predominate over TFP in GDP growth,
• the increasing role of IT investment in GDP growth,

However, a further significant trend is that their data shows a pattern whereby capital is the predominant input to GDP growth in developed economies – i.e. as economies develop they make a transition from labour-intensive to capital-intensive growth. Such a finding is of considerable importance:

• It indicates that, given such a pattern, an economy and its policy makers should anticipate growth becoming more capital intensive as an economy moves towards developed economy status.
• East Asian developing economies form an ‘intermediate’ group between the developed economies on the one side and the majority of developing economies on the other – although in greater reliance on capital inputs for growth than most developing economies they more resemble developed economies.
• Most developing economies are more dependent on labour inputs compared to capital inputs for GDP growth compared to developed economies.
• Such a transition from labour-intensive growth to capital-intensive growth as economies develop is in line with classic formulations of economic theory flowing from Adam Smith.
• Jorgenson and Vu’s data provides clear evidence in line with the classical economic view that as an economy develops its pattern of growth becomes more capital intensive, but it provides no evidence supporting views that as economies become more developed the role of factor inputs in GDP growth declines relative to TFP.
• Such a transition from labour intensive to capital intensive growth with economic development, while foreseen by classical economics, is not theorised in a number of standard contemporary treatments of economic growth – for a brief historical review see (Ross, 2009).(15)

The data produced by Jorgenson and Vu, and the trends it reveals, is therefore of great importance both from the practical point of view of view of study of economic growth and policy making, and from the point of view of economic theory.

* * *

Since this analysis was carried out Jorgenson and Vu have extended their data to 2008. (Jorgenson & Vu, 2010) The new data does not alter the main trends analysed above. A detailed analysis from the angle of approach in this article will be published here.

Notes